Alagie Darboe Chapter 5 Homework from Lecture Problem 1

Suppose that Bethlehem Steel has a current sales level of $2.5 billion, variable costs of $2 billion, and fixed costs of $400 million. If sales rise by 15 percent, how much will pre-tax profit increase in dollar terms? What will be the percentage increase in pre-tax profit? What explains the relationship between the percentage change in sales and the percentage change in pre-tax profit for Bethlehem? Answer: Sales in $(000) Variable Cost Fixed Cost $(000) Current Pre-Tax Profit

2,500,000,000.00 2,000,000,000.00 400,000,000.00 100,000,000.00

New sales after 15% rise 2,875,000,000.00 New Variable cost 2,300,000,000.00 Fixed Cost 400,000,000.00 New Pre-Tax Profit Increment in Pre-tax Pro.
Percentage Increase 175,000,000.00 75,000,000.00 75%

This problem demonstrates the potential effects of operating leverage.

re-tax profit hat explains nge in pre-tax

Alagie Darboe Chapter 5 Homework from Lecture Problem 2

In early 1990, Boeing Co. decided to gamble $4 billion to build a new long-distance, 350seat wide-body airplane called the Boeing 777. The price tag for the 777, scheduled for delivery beginning in 1995, is about $120 million apiece. Assume that Boeings $4 billion investment is made at the rate of $800 million a year for the years 1990 through 1994 and that the present value of the tax write-off associated with these costs is $750 million. Based on estimated annual fixed costs of $100 million, variable production costs of $90 million apiece, a marginal corporate tax rate of 34 percent and a discount rate of 14 percent, what is the break-even quantity of annual unit sales over the Boeing 777s projected 15-year life? Assume that all cash inflows and outflows occur at the end of the year.
Units sold per year Price per unit Variable cost per unit Fixed Costs Initial cost Life of the project Discount rate Depreciation Tax Rate 1 120,000,000 90,000,000 100000000 4,000,000,000 15 years 14% 34% - PV (cost) + PV(depreciation tax shield) + =

$ $ $

SL

PV(operating CF's) NPV

$ 4,000,000,000 Initial cost 266,666,667 depreciation/year 34% Tax Rate 90,666,667 6.1422 PVIFA

PV (cost) PV(depreciation tax shield)

PV(operating CF's)

(Price-Cost)(units)(1-tax rate)PVIFA10,10

price cost price-cost # of units (Price-Cost)(units) 1 minus the tax rate PVIFA (1-tax rate)PVIFA10,10

120,000,000 190,000,000

310,000,000 1 310,000,000 0.66 6.1422 4.053852

PV(operating CF's)

1,256,694,120

- PV (cost) + PV(depreciation tax shield) + =

PV(operating CF's) NPV

$ 4,005,000,000 PV(operating CF's) 267,000,000 depreciation/year 34% 90,780,000 6.1422 PVIFA 557,588,916

PV (cost) PV(depreciation tax shield)

$ PV(depreciation tax shield) $

PV(operating CF's)
price

(Price-Cost)(units)(1-tax rate)PVIFA14,15
$ 120,000,000

cost price-cost # of units (Price-Cost)(units)

$
$ $ $

90,000,000

reduced variable cost 210,000,000 1 210,000,000 0.66 1-tax rate 6.1422 PVIFA 4.053852 851,308,920

(1-tax rate)PVIFA10,10

PV(operating CF's)

Breakeven occurs when: PV(operating CF's) = PV (cost) - PV (depreciation tax shield) (4000000000-(190000000*5))(X)(.66)(6.1422)
PV (cost) 0 3050000000 4.053852 12364248600 $ 4,000,000,000

$
$

4,000,000,000

0 units

d a new long-distance, 350or the 777, scheduled for delivery Boeings $4 billion investment is ugh 1994 and that the present illion. Based on estimated annual million apiece, a marginal nt, what is the break-even 5-year life? Assume that all cash

see below for individual calc's

$
$ $

(4,000,000,000)
1,256,694,120

(2,743,305,880)

15 yrs, 10% discount rate

http://www.miniwebtool.com/pvifa-calculator/?r=14&n=15

see below for individual calc's

$
$ $

(4,005,000,000)
557,588,916 851,308,920

(2,596,102,164)
added 5 mil to initial investment

15 yrs, 14% discount rate

http://www.miniwebtool.com/pvifa-calculator/?r=14&n=15

ate)PVIFA14,15

15 yrs, 14% discount rate

ost) - PV (depreciation tax shield) 0*5))(X)(.66)(6.1422)

PVIFA Calculator

Interest rate per period:

Number of period:

PVIFA Result

6.1422

added 5 mil to initial investment

Alagie Darboe Chapter 5 Homework from Lecture Problem 6

For the following project, the chief financial officer has prepared a set of certaintyequivalent factors to adjust the cash flows for the estimated risk. The economics department has also prepared a set of risk-adjusted interest rates at which to discount the projects cash flow. The projects initial investment is $150,000 and the Treasury security rate is 8 percent
Year Cash flows ($000) Certainty equivalents (finance department) Risk-adjusted rates (economics department) 1 $50 0.982 10% 2 $75 0.964 12% 3 $130 0.947 14%

a) What is the NPV of the project from the finance departments estimates?
Answer: Year Finance department NPV(000s) $55.177 1 $49.10 2 3 $72.30 $123.11

b) What is the NPV from the economics departments estimates?

Answer: NPV(000s) 42.9904

c) What would you advise the company to do? Answer:

Accept the project because it has positive net present value. The finance department method (CEQ) may be more reliable if risk and time value are measured consistently and separately.

partment has cash flow.